Definition of Contribution Margin (CM)

difference between sales and the variable costs of the product or service, also called marginal income. It is the amount of money available to cover fixed costs and generate profits. For example, if sales are $15,000 and variable costs are $6100, contribution margin is $8900 ($15,000 less $6100). Determining the contribution margin has many advantages. A company can sell an item below the normal selling price when idle capacity exists as long as there is a contribution margin since it will help to cover the fixed costs or add to profits. Also, the CM calculation requires the segregation of fixed and variable costs, which is needed in break-even analysis. Further, CM analysis is good in evaluating the performance of the department as a whole and its manager. However, the contribution (margin) income statementcan only be used internally by management because it is not acceptable for external reporting in the annual report.